Insurance for Islamic Finance

Islamic banking and finance have become integral components of the global financial system, and Islamic financial products have gained wider acceptance in many economies. The Islamic insurance industry is called “takaful,” which represents an important component of the Islamic financial system. In Turkey, Islamic insurance (takaful) is referred to as “participation insurance,” and so far only a few Turkish banks with an Islamic practice, known as “participation banks,” have begun offering takaful. The legislative basis in Turkey for takaful is still being debated, but there is a Draft Law[1] that would amend the Insurance Law[2] to include the definition of “participation insurance.” Once the draft law is passed, participation insurance is expected to develop rapidly given the vibrant Islamic finance industry in Turkey. 

How does takaful work?

Takaful is founded on the principles of cooperation, and separation between the funds and the operations of shareholders, thus passing the ownership and operation of the takaful fund to the policyholders. In takaful, the policyholders are joint investors along with the insurance vendor (the takaful operator), who acts as a manager (mudarib) for the policyholders.[3] The policyholders share in the investment pool’s profits. A positive return on policies is not legally guaranteed, as any fixed guarantee of profit would be akin to receiving interest, and run afoul of the Islamic prohibition against unearned income (riba).

All participants (policyholders) agree to guarantee each other, and they make contributions to a mutual fund, or pool. The pool of collected contributions creates the takaful fund. Premiums are reflected as contributions, and capital is segregated from the participants’ funds.[4] The amount of contribution that each participant makes is based on the type of coverage they require. As in conventional insurance, the policy (takaful contract) specifies the nature of the risk and the period of coverage.

The takaful is managed and administered on behalf of the participants by the mudarib, who charges an agreed fee to cover costs. Any claims made by participants are paid out of the takaful fund, and after making provisions for the likely cost of future claims and other reserves, any remaining profit belongs to the participants in the fund, and not to the takaful vendor/manager/operator (typically the mudarib). The profit may be distributed to the participants in the form of cash dividends, distributions, or a reduction in future contributions. It is also important to note that an essential dimension of takaful is that the fund should only be invested in projects that are in line with approved Shari’ah principles.


Practice and legislation in Turkey

A few participation banks are already offering participation insurance products to their customers. While there is currently no legislative basis for participation insurance, the Insurance Law does not preclude participation insurance. Once the new Draft Law is passed however, the legislative basis is expected to foster much wider integration of participation insurance into the Turkish financial system.

The Draft Law, currently proposed by the Grand National Assembly’s working commission, includes a definition for “participation insurance” to be included under the Insurance Law. According to the Draft Law, participation insurance is defined as an insurance type where the insurer, incorporated under the principles outlined in the Insurance Law, provides insurance in accordance with participation principles and operates accordingly.[5] 

The Draft Law requires participation insurance companies to meet the same prerequisites and conditions for establishment as conventional insurance companies, and they must also be operated according to participation insurance principles.[6] Under the Insurance Law, insurance companies must be incorporated either as a corporation or a cooperative.[7] Insurance and reinsurance companies must obtain a license from the Undersecretary of the Treasury for each type of insurance they offer.[8] Technically, insurance and reinsurance companies must also have sufficient reserves for their obligations arising from all insurance contracts.[9] The Undersecretary of the Treasury should approve the content of all insurance contracts to be executed with the insured, and all insurance companies must include the same general principles in all insurance contracts.[10] Special terms may be included however, depending on the requirements of each type of insurance contract.[11] 

The policyholders of takaful will receive the profit from their investments (minus a management fee or expenses). Insurance brokers include a special term under the general insurance contract in order to distribute the profits to the policyholders in proportion to their participation in the fund. In the takaful system, the insured are entitled to the whole amount of the premiums, a share of the profit made over the premiums, a bonus, and dividends according to the company policy, upon expiry of the relevant insurance policy. If there is premature termination, the insured is given the investment share, along with profit, and a pro rata share in underwriting surplus. Whereas in conventional insurance, a premature termination does not grant any right to the insured nor does the insured have any pro rata share in underwriting surplus. 

A future for reinsurance in the form of “re-takaful”

In principle, a reinsurance (re-takaful) contract for Islamic companies should also be drafted in conformity with Shari’ah. However, there is currently a shortage of re-takaful capacity globally, and the lack of companies in the market presents a challenge as well as an opportunity. For the time being, this need is being imperfectly met by conventional reinsurance with the approval of Shari’ah scholars, although Shari’ah boards of Islamic finance institutions would strongly prefer an actual re-takaful.

The global Islamic financial system has emerged as a stable, predictable, yet competitive alternative to the traditional financial system, which is subject to volatile market conditions. Thus, the Islamic financial product spectrum is rapidly expanding, including components of banking, capital markets, and the takaful industry. Turkey is taking steps to develop a comprehensive Islamic financial system by integrating its legislation with various Islamic capital markets products, and regulating participation banks. Takaful is expected to be the next financial instrument in the Turkish Islamic financial system, truly enabling Islamic finance to operate in parallel with the conventional financial system.


[1] The Draft Law No. 1/982 of 20 October 2014 on the Amendment of Certain Laws and Decrees and Banking Law. 

[2] The Law on Insurance, Law No. 5684, Official Gazette of June 14, 2007 No.26552.

[3]  Further information on takaful principles may be found on the Institute of Islamic Banking and Insurance website:

[4] Camilla Hall, XL Group Could Seek to Tap Islamic Demand for Insurance Products, FINANCIAL TIMES,

[5] The Draft Law No. 1/982.

[6] Id.

[7] Law No. 5684, Article 3.

[8] Law No. 5684, Article 5.

[9] Law No. 5684, Article 17.

[10] Law No. 5684, Article 11.

[11] Id.